Is the Southern Company Dividend Safe?
Let’s work through a Southern Company dividend analysis.
Southern Company is one of the first stocks I bought in 2003 when I started building my dividend stock portfolio. On the other hand, I have not added to my position in Southern stock since early 2018.
Furthermore, the company has encountered operating challenges in the last few years. And I am a little concerned about the safety of the large dividend that Southern stock pays me as an investor.
Southern Company Dividend Stock Analysis
So let’s see if my concern is real. Is the Southern Company dividend safe? If yes, is Southern Company a good investment?
Let’s find out the answer to these questions and more. To do so, let’s run Southern stock and the Southern Company dividend through a dividend stock analysis.
But before we get started, please note that Southern stock trades on the New York Stock Exchange under the ticker symbol – SO.
Related: Duke Energy dividend stock analysis
Southern Company Background
Southern provides energy to customers in the United States through:
- Electric operating companies
- Natural gas distribution companies
- A generation company serving wholesale customers in all states across American
Furthermore, Southern Company is a nationally recognized provider of energy solutions, as well as fiber optics and wireless communications.
Source: Southern Company – About Us
The company’s service territories are focused in the Southeastern and Mid South United States.
Perhaps you are a customer and do not even know it. I am a Nicor Gas customer. Until I wrote this article, I didn’t know they were a subsidiary of Southern Company.
It’s a circular process. I pay my gas bill and some of those profits fund my quarterly Southern Company dividend!
Some of Southern Company’s major subsidiaries include:
- Alabama Power
- Atlanta Gas
- Central Valley Gas Storage
- Chattanooga Gas
- Georgia Power
- Jefferson Island Storage & Hub
- Mississippi Power
- Nicor Gas
- Pivotal LNG
- Southstar Energy Services
- Southern LINC Wireless
- Southern Power & Southern Telecom
- Virginia Natural Gas
Taken together these subsidiaries service more than 9 million customers across the territories they cover. Source: Southern Company – Service Territory
Based on customer count, Southern is one of the largest regulated utility companies in America. Approximately 90% of earnings come from state-regulated businesses.
Slow, Steady, Stable Stocks
A major appeal of regulated utilities is higher predictability and lower investment risk.
Regulated utilities are some of the most stable stocks for your investment dollars. If you like investing in slow and steady stocks, regulated utilities usually fit that profile.
This assumes the regulated utility has positive relationships with the state regulatory bodies in its service areas. And Southern has historically maintained excellent regulatory relationships.
Southern Company Business Risks
In contrast, Southern does have some business risks to consider.
Specifically, Southern has struggled with cost overruns from the construction of two new nuclear power plants. These plants are referred to as Vogtle and Kemper.
Because of the costs related to bringing these projects to completion, the company has had to take on significant amounts of debt. However, based on Southern’s recent earnings presentation, they expect financial leverage to remain stable for the next 5 years.
Southern Company Dividend Yield
Southern’s stock pays an annual forward dividend of $2.48 per share. Based on the recent stock price, the Southern Company dividend payout puts the dividend yield at a very attractive 4.1%.
Let’s see what Southern Company dividend growth looks like next.
Southern Company Dividend Growth
|1 Year||3 Years||5 Years||7 Years|
Dividend growth has been slow and steady. This is exactly what you would expect from a regulated utility.
As I said before, regulated utilities have some of the most stable stocks. And, the most consistent stocks you can find.
Consecutive Years of Southern Dividend Increases
Finally, Southern Company has a nice streak of annual dividend increases. Specifically, 19 years in a row of paying out more dividends per share.
Let’s see what some of the business fundamentals look like next.
Historical Revenue Trend
Organic revenue gains come primarily from population growth and economic development in their service territories.
In addition, Southern Company and AGL Resources completed a merger in 2016. Under the merger agreement, AGL Resources became a new, wholly-owned subsidiary of Southern Company. The merger added to revenue growth in 2016 and 2017.
Southern Company Dividend and Earnings Per Share
Earnings have been pressured in recent years by cost overruns at the Vogtle and Kemper expansion projects. This has led to a Southern Company dividend payout ratio near 100% based on earnings per share.
After eliminating cost estimates to complete the Vogtle and Kemper expansions. And, adjusting for one-time impacts from mergers and acquisitions, management believes core earnings will grow by about 5% each year. This seems reasonable for a regulated utility.
Southern Company Dividends Versus Free Cash Flow
As the chart above shows, free cash flow is negative. For most companies, free cash flow exceeds the dividend. Then dividends are paid from free cash flow.
In Southern’s case, both the negative free cash flow and the dividend payments have to be financed. Southern Company has done this primarily by taking on additional debt. They have also sold additional shares of stock to bring in cash to fund the deficit. This is not an ideal situation, but typical for a regulated utility.
Utility stocks have large capital expenditures. These costs are what create negative cash flow. Both Duke Energy and American Electric Power also have negative cash flow. So, earnings are usually a better indicator of dividend-paying capacity.
It is typical for regulated utilities to borrow large sums of money to support their operations and cash needs. They can do this because of the predictability of their businesses.
So let’s take a look at Southern Company’s balance sheet and credit rating next to check Southern’s financial position.
Here is the recent trend for Southern’s debt to equity ratio.
|Debt to Equity Ratio||1.3||1.8||2.0||1.6||1.5|
The largest increase in debt was in 2016. This was partly to fund the merger with AGL.
It’s good to see debt decreasing in 2018. Plus holding steady in 2019.
The balance sheet is not in as bad of shape as I thought it might be. To compare, Wisconsin Energy Group’s debt to equity is 1.2 and Dominion Energy’s debt to equity is 1.6.
Southern Company has an “investment grade-moderate credit risk rating from both Moody’s (Baa2) and S&P (BBB+).
Southern’s ratings are a little lower than the typical dividend stock, but also not as bad as I thought they might be. They are consistent with other utility companies.
Is Southern Company Dividend Safe?
Southern Company’s dividend metrics and business fundamentals are not too different than other regulated utilities. But, the debt load and project cost overruns need to be watched closely in the coming months.
I believe the dividend to be safe from a reduction in the foreseeable future. But, there is some risk.
I also checked with the Utility Forecaster investor newsletter. Their proprietary dividend safety score is 2 out of a possible 8 for Southern Company.
The Utility Forecaster score does not mean the dividend will be cut. It just means it has more risk than many of the other 200+ stocks and dividends that they monitor.
Southern Company Dividend Growth Forecast
Based on my analysis, I conclude that the Southern Company dividend will continue to grow. My projection is for a 3% annual dividend growth rate in the coming years.
I’m assuming management will be able to increase core earnings by 5% each year. This combination of earnings and dividend growth will allow the dividend payout ratio to drift lower.
A lower dividend payout ratio is a positive metric. It will add to dividend safety in the future.
Southern Company Stock Valuation
Let’s judge the value of Southern Company stock in several ways:
- Southern Company dividend discount model
- Stock price to earnings ratio
- Morningstar fair value estimate
- Utility Forecaster stock price buy limit
As I think about the different valuation measures, I conclude that Southern Company stock is overvalued.
Let’s check it out…
Southern Company Dividend Discount Model
The single-stage dividend discount model considers several factors I have discussed thus far.
- Current dividend payment – $2.48 per share
- Projected dividend growth – 3.0%
- My desired annual return on investment – 9%
Using these assumptions, the dividend discount model calculates the fair value at $43 per share.
Southern Stock Price to Earnings Ratio
The Southern Company stock price to projected 2020 earnings sits at about 25 times. This is higher than many of Southern’s peer companies that trade in the high teens or low 20s.
The S&P 500 forward price to earnings ratio for 2020 is also about 23 times. But keep in mind 2020 earnings for S&P 500 companies are very uncertain right now.
Morningstar Fair Value
Next, the investment analysis firm Morningstar believes Southern Company stock is fairly valued at $58 per share.
Utility Forecaster Investment Newsletter
Finally, Utility Forecaster has a “hold” on Southern stock.
Southern Company Dividend Stock Analysis Conclusions
Southern holds a large position in my portfolio. At the time of writing it is my 7th largest holding. So, I like to keep a close eye on it.
Is Southern Company A Good Investment?
I think Southern Company is a good investment for me. It fits with my overall investment objectives of current income plus income growth.
It has a very substantial dividend yield, plus low single-digit percent dividend growth. I expect the dividend to grow at a similar rate in the near future.
Southern operates in a steady industry with predictable demand. On the other hand, they have significant operating challenges and cost overruns relative to the Vogtle and Kemper projects.
Even after the recent stock price decrease, the stock appears overvalued. And the stock comes with some risk.
In the short run, the dividend does not appear to be at risk. However, it is one of the more risky dividend payouts of the regulated utilities covered in my model dividend stock portfolio.
My Path Forward With Southern Stock
I intend to hold my position, but monitor company performance more closely than I do with most of my dividend stocks. I have no interest at this time in adding to what is already a large holding in my portfolio.
As is usually the case with dividend growth stocks, higher dividend yields come with more risk and lower projected dividend growth. And, the Southern Company dividend is no exception.
Further Reading About Slow And Steady Stocks Like Southern Company
- Rapid growth from NextEra Energy (NEE)
- Another regulated utility analysis: American Electric Power (AEP)
- How to pick dividend stocks
- Living off dividends in retirement
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